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Classification Of Accounts

Classification of Accounts:

An account is a record in the general ledger that is used to collect and store debit and credit amounts. For example, a company will have a Cash account in which every transaction involving cash is recorded. If the company sells merchandise for cash, the Cash account will be debited and the Sales account will be credited.

We can classify accounts in two different ways. These are:

Traditional classification of accounts

Modern classification of accounts

Traditional Classification of Accounts:

This is very old method of classifying accounts and is not used in most of the advanced countries. Under this method, accounts are classified into four types. These are:

Personal accounts

Real accounts

Nominal accounts

Valuation accounts

Personal Accounts:

These accounts show the transactions with the customers, suppliers, money lenders, the bank and the owner. A business may have many credit transactions with the above persons or organizations. A separate account is to be prepared for each of them. Persons or organizations with whom the business has credit transactions are either debtors or creditors. If they have to give some money to the firm, they are called debtors. Conversely, if the firm is to pay them some money they are known as creditors. The main purpose of preparing personal accounts is to ascertain the balances due to or due from persons or organizations.

Real Accounts:

These accounts are accounts of assets and properties such as land, building, plant, machinery, patent, cash, investment, inventory, etc. When a machinery is purchased for cash, the two accounts involved are machinery and cash – both are real accounts. But if the same machine is purchased from Z & Co. on credit, for example, two accounts involved will be those of machinery and Z & Co., the former being a real account and the later being a personal account.

Nominal Accounts:

These are the accounts of incomes, expenses, gains and losses. Examples of nominal accounts are wages paid, discount allowed or received, purchases, sales, etc. These accounts generally accumulate the data required for the preparation of income statement or trading and profit and loss account.

Valuation Accounts:

These are the accounts of provision for depreciation and provision for doubtful debts. Where fixed assets are maintained in the books of accounts at original cost, to reflect the actual book value of the assets, a provision for depreciation account on the credit is maintained. In the balance sheet, it is shown as deduction from the original cost of the asset. Similarly, if the debtors’ personal accounts are retained at total amount due, a valuation account on the credit – provision for doubtful debts is required. In the balance sheet, it is shown as a reduction from sundry debtors account to reflect estimated realizable value.